(Nov 18): What could trigger a recession in the US? In the past, a tightening labour market after a period of expansion served as an early warning sign. Workers would become more difficult to find, wages would start climbing, corporate profit margins would tend to shrink and firms would start raising prices. Fearing inflation, the central bank would then raise interest rates, which in turn would depress corporate investment and spur layoffs.
At this point, aggregate demand would fall as consumers, fearing for their jobs, reduced their spending. Corporate inventories would then rise, and production would be cut further. Growth would slow significantly, signalling the beginning of a recession. This cycle would then be followed by a recovery. After firms worked down their inventories, they would start producing more goods again; and once inflation had abated, the central bank would cut interest rates to boost demand.
But this description seems to apply to a bygone era. Because inflation is now persistently muted, it is no longer a reliable trigger for interest-rate hikes and the slowdowns that follow. More recent recessions have been precipitated inIs economic winter coming? stead by financial excesses accumulated during the expansion. In 2001, the excess was in stock-price growth during the dotcom boom; in 2007-2008, it was in financial-sector leverage following the subprime mortgage boom. And while rate hikes by the US Federal Reserve preceded these recessions, they were not responses to above-target inflation, but rather attempts to normalise monetary policy before inflation actually took off.